Journal of Risk Model Validation

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Empirical validation of the credit rating migration model for estimating the migration boundary

Yang Lin and Jin Liang

  • Develop a steady model for pricing long term bonds with credit migration risk, under a structural framework.
  • The free boundary point of the model is the credit rating migration point, where the existence is proved.
  • The model is validated by applying it to long-term bonds to estimate the migration boundary, for the first time.
  • The empirical results show that the model offers an applicable method in identifying the credit migration boundary and provides preliminary evidence of the effectiveness of the model.

In this paper, a structural model for credit rating migration is developed and validated, by which the migration boundary is recovered for the first time. The model is a steady-state model based on the 2015 framework by Hu et al and is applied to two long-term corporate bonds. The empirical results show that the theoretical boundary values fit practical ones quite well. This research shows that the model offers an applicable method to identify the credit rating migration boundary and provides preliminary evidence of the effectiveness of the model.

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